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A bank is planning to make a loan of $5 000 000 to a firm in the steel industry. It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years and a duration of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 per cent. Assume the bank has estimated the maximum change in risk premium on the steel manufacturing industry to be approximately 4.2 per cent based on two years of historical data. The current interest rate for loans in this sector is 12 per cent. Estimate the loan risk for this loan. (3 marks)
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